MIAMI — July turned out well for consumers in the market for airline tickets. According to Consumer Price Index (CPI) data from the Bureau of Labor, airfare prices slipped 5.6% between June and July, leaving some extra dollars in the pockets of consumers.
The cheaper airfare comes as Congress investigates the airline industry and its key players for colluding to keep fares high. Drastically high prices in May after Amtrak’s outage, which pushed many in need of speedy travel to the airlines, drew some attention from the Department of Transportation. The Justice Department also revealed in July that it would examine whether airlines colluded by tacit signals to restrain capacity. In light of the ongoing investigations, many view cheaper airfares as an attempt by the airline industry to cover up signs of collusive behavior and dodge federal probing.
But interpreting the decline in this sense misses the mark. While federal inspection certainly brings out the best behavior from the airlines, a series of other factors better explain the relief in the price of traveling. Competitive pricing pressure in the Dallas and Chicago markets, realizing more savings from less costly jet fuel, and effects from unbundling practices more likely padded fliers’ wallets than a reaction designed to smudge any evidence of cheating.
The repeal of the Wright Amendment at Dallas Love Field last October stands behind much of the pricing pressure manifested by July’s dip in airfares. Prior to its removal, the Wright Amendment artificially limited service from Love to mainly a few surrounding states, leaving neighboring American Airlines at Dallas / Ft. Worth virtual monopolies on many non-stop routes and the pricing power to set fares. Southwest jumped at the opportunity to add more service from the area, and now flies non-stop from the airport to fifty destinations, a sharp uptick from the days dogged by the Wright Amendment.
The competitive punches flying in Dallas have spilled out into other markets as well, most namely Chicago which faces similar pricing pressure. These two markets house major aviation hubs, with American Airlines, Southwest Airlines, and United Airlines each headquartered in one of the two cities and supporting major operations at the corresponding airports. Many airlines including these three have voiced difficulties in maintaining strong unit revenue, struggling with passenger revenue per available seat mile (PRASM) headwinds. July’s relatively dramatic break in airfares greatly stems from some pent-up downward pressure being released. Competition, not collusion, brought about these effects.
Additionally, with more distance from the days of highly priced jet fuel, which began its decline last year, the airlines may have decided to deploy some of those savings in the form of cheaper airfares. Many in the political sphere question the airlines’ initial irresponsiveness to more affordable jet fuel, which composes more or less a third of a flight’s total operating costs. However, virtually all airlines engage in some degree of fuel hedging, signing long term agreements to buffer price fluctuations to allow more cost predictability. With jet fuel falling off the table so sharply, the airlines actually realized only a sliver of these savings off the bat, paying well above market rates.
As more time passes the airlines gain more liberty from those hedges. The airlines price first and foremost according to supply and demand, not input costs – but the savings from jet fuel definitely allow the airlines to more easily discount airfares. Record high load factors, the percentage of available seats an airline actually sells, also spread the remaining costs more thinly among passengers. The potent combination of lower costs and distributing those costs more widely pulls down the break even point an airline must allocate per seat to justify a flight.
As they begin to bank more money from low fuel prices, many airlines have probably decided to pass along some of those savings to the consumer, especially given the warm competitive fire burning in Dallas and Chicago. The International Air Transport Association (IATA) predicted this with stunning accuracy months ago, so viewing descending airfares as a sudden response to government investigations wildly misses the mark.
The industry’s fully-invested embrace of unbundling as business practice also helps to explain the dip during July. The economic downturn in 2008 severely challenged the price airlines could charge for air travel. Rapidly fading demand, particularly on the part of more budget conscious leisure travelers, pulled down airfares with supply not able to match demand as quickly. As a result, many airlines gradually unbundled from a ticket formerly complementary elements and tacked on an additional fee, with checked baggage functioning as a notable example. This allowed airlines to price discriminate more heavily, slowing some of the demand outflow while continuing to generate more revenue from those willing to pay for extra services.
July represents the peak of leisure travel season, with a greater concentration of vacationers taking to the skies. Unbundling as a strategy proves most effective with this audience, magnifying its effects during the height of summer travel. As displayed in the graph to the left, something very similar, if slightly more tempered, transpired last July as well. The CPI data only accounts for revenue stemming directly from the base price of a ticket. Some portion of the seemingly precipitous airfare fall may very well result from the offshoots of unbundling taking a stronger hold as summer travel heats up, even as airlines pull in more ancillary revenue than ever.
On the supply side of the equation, many U.S. majors plan to grow capacity – despite what the shouts of collusion would have you believe. Southwest Airlines for one has served as a particular disruptor. The airline plans to grow at a relatively ambitious rate of seven percent in 2015, an aggressive figure which shatters the notion that it communicates with its rivals to pin down capacity. Other large airlines have also added capacity throughout the year, even amidst pleas from investors to remain flat. Many have simply done it more prudently than in the past by upgauging existing planes rather than adding more to the fleet – undeniably growing nonetheless.
The growth plans posted by many U.S. majors make it awfully difficult to believe allegations that airlines are conspiring to hold back capacity. While the airlines try to appease investors, who’d prefer the airlines limit growth to maintain pricing power, downward sloping unit revenues across the industry suggest just how powerfully competition currently characterizes the industry.
Besides, if the airlines truly wished to cover up any collusion, rapidly slashing prices would be the surest way to point a finger at themselves. As with any repeated interaction, airlines face a shadow of the future effect and know well that responding too heavily to evade lawsuits (if that were indeed their intention) would only magnify the attention Congress pays to them down the road. Logically, trying to slip under the radar would probably accompany a more modest response (the 5.6% fall represents the greatest month-by-month in nearly two decades, for some perspective), so the idea that federal intervention drives the airfare slip just doesn’t add up.
Far more reasonably, we should tie the more affordable travel in July to fierce competition across the system, paired with downward sloping costs and evolving industry practices that may slightly skew airfare data over short periods. Digging too deeply into month-over-month fluctuations carries its own danger, but the rather awe-inspiring drop in July does speak to the ferocity of blows being dealt within the industry, especially in Dallas and Chicago. Cries of collusion and unlawful cooperation are woefully misplaced.
Leave the chants of “Monopoly” for game night, because this is a competitive industry. Outwardly spreading pricing pressure, jet fuel, and unbundling paved the way for July’s airfare descent, not a response to congressional activity. With the fight continuing to flare in Dallas and Chicago, and with fuel showing no signs of rebounding sharply, expect air travel to remain similarly affordable in the near future.